Rolling Budgets, with a Twist

A full-blown rolling budget isn't practical at many companies. But some finance executives have found that a scaled-back approach suits them just fine.Marie Leone, CFO.com | USJune 3, 2003

From his office in Valley Forge, Pennsylvania, Bruce Borquist uses the Internet to collect daily budget changes tied to hyperinflation in El Salvador, on-again, off-again irrigation projects in the Democratic Republic of the Congo, and hospital reconstruction in Nepal. Borquist, the CFO of International Ministries, sings the praises of his Web-based budgeting and planning (B&P) software that allows 70 area directors in 23 countries to work with real-time budget information.

But Borquist doesn't have much interest in a full-scale, six-quarter rolling budget. Neither does Rose Melillo, financial systems manager at manufacturer Murray Inc., or Todd Richardson, budget manager at Mercy Health Partners of Western Ohio, or David Foley, senior director of financial planning at 24 Hour Fitness.

Even Erin Lavelle — who cut her B&P teeth at GE Capital, where three different real-time budgets ran at once — doesn't think the process is right for her new company, privately held Mesirow Financial. Lavelle, the vice president of planning and analysis at the financial services firm, now uses a modified rolling budget.

For years, corporate users and software vendors have tried to get full-scale rolling budgets… well… rolling. The promise of commingling real-time financial, operational, and economic information is intoxicating, but at many companies, not practical.

Slowly I TurnMost finance executives don't want to deal with the burden of a rolling B&P process. To truly integrate such systems, management would have to abandon annual budgets — and the compensation schemes that are based on these yearly goals — notes Lawrence Serven of Stamford, Connecticut-based consultancy The Buttonwood Group. Part of the compensation revamp would force executives to embrace the use of key performance indicators (KPI) in concert with financial metrics, in a collaborative effort that would link operations to finance. But fundamental structural changes like these are difficult to implement and time-consuming to adopt.

Most software users find themselves halfway between static, Excel-based B&P and full, dynamic, rolling budgets. But halfway is better than no way: In the modified approach, the software can monitor and direct budget adjustments, helping to cut down on surprises at the end of the year. The software also decentralizes part of the B&P process by moving many responsibilities to front-line managers.

Serven reckons that the modified rolling budget is really the corporate norm. Most companies that begin full-blown rolling B&P projects, he maintains, eventually scale back the technology to fit traditional 12-month planning processes. One big reason, according to Serven's estimates, is that 80 percent of these companies look for quick software fixes, rather than adjusting their processes before turning to technology. Only after software implementation — perhaps years later — do they begin to change their budgeting culture and processes.

The Missionary's Position"I tried to get out of the business of making micro decisions about the budget," recalls Borquist, who oversees the $16 million budget of International Ministries. Essentially, he pushed B&P responsibilities down to the area directors — Baptist ministers scattered across the globe — by putting Web-based B&P tools from FRx Software in their hands.

Figuratively (and sometimes literally), International Ministries is in the business of teaching people to fish. So the corporate culture is "pretty participatory and decentralized," notes Borquist, who proceeded to get buy-in from front-line managers who build annual budgets and apply for corporate grants. Adds Borquist, "there was a great sigh of relief when I handed the regional directors the new tools."

At Chicago-based Mesirow Financial, Erin Lavelle also favors a hybrid approach. Using tools from SRC Software, the vice president of planning and analysis "constantly reevaluates" budgets and forecasts — offline. By her lights, the level of data she deems necessary is too granular for into a real-time rolling budget, which would be better served by summary information.

Lavelle maintains that she doesn't "really forecast" with the tool; she creates trend analyses to help determine whether business units at the $182 million (in revenue) company are on course. "As soon as you see you've stepped off the budget path," says Lavelle, "you can adjust operations to help you get back on target."

Furthermore, contends that even stepping off the path — as long as you know you've strayed — can suggest new products and opportunities. For example, a downturn in one product line may be an indication that another line is about to develop. By seeing this variance in a monthly update, managers can redeploy people, capital, and raw materials to navigate around the downturn and still meet corporate revenue goals.

As you might expect, most of Mercy's 200 department heads, spread across eight hospitals, aren't CPAs — they're RNs and MDs. Since the B&P process, which includes a monthly look at budget variances, pulls many of them out of their comfort zone, Richardson prescribed some practical training. For instance, he showed nursing supervisors that budget variances were directly linked to a patient's length of stay. Therefore, if stays were shortened by better care, budget goals could be met more easily.

The rolling budget also eliminated the "finance department excuse," quips Richardson. Although the hospital leadership sets initial budget assumptions, the bottom-up approach gave line managers complete ownership of their department budgets so that "if during the year managers start to blow the budget, they can't blame the finance department for missing a target." Borquist agrees; in his words, decentralizing the budget process "got the budget monkey off my back."

Shock the Monkey

The finance department isn't the only group saddled with the budget monkey. Budgets — whether traditional, rolling, or somewhere in between — create tension for every manager who is "exposed by the budgeting process," asserts David Murray, CFO of B&P software provider Longview Solutions. Corporate reputations can be made — or broken — he adds, by how managers set and perform against their budgets.

Budgets also hold managers accountable for predictions, and depending on the corporate culture, that can create boatloads of anxiety, reasons Elizabeth Lake Key CEO of Denver-based consultancy Lake Business Development. Some corporate personalities react to missed targets with cost-cutting, says Key; an extreme would be layoffs. Others seek more creative solutions, such as exploring untapped markets.

The budgeting process is also stymied by the operational perspective of line managers, who see budgeting and planning as an interruption in business, irrelevant to their day-to-day efforts. That's especially true when the budgeting process is a traditional, command-and-control effort, which eschews practical input from front-line managers in favor of rigid, top-down targets, argues Jeremy Roche, CEO of B&P software provider CODA Group.

His U.S.-based colleague Steve Pugh, CEO of CODA Financials, is struck by the futility of this "stale" management style. For example, when executives feel free to demand a 15 percent revenue increase mapping out how to reach that target, asserts Pugh, the budget might be padded or otherwise "gamed" by each manager before it's passed down the line. "By the time it gets to the lowest manager," concludes Pugh, "the 15 percent mandate has grown to 35 percent, and every manager knows it's padded and an irrelevant target."

Dazed and ConfusedModifying the budgeting process to give line managers more responsibility can give them more confidence in their targets — but it can also breed confusion about which target they need to hit, says Buttonwood's Serven.

Even executives who support rolling budgets still expect their line managers to use annual budgets as a benchmark to measure operating performance. But this is rarely communicated properly, notes Serven, who adds that the continuous planning and hyperresponsiveness of rolling budgets often creates a lack of focus.

In fact, one CEO confessed to a major software vendor that he abandoned rolling B&P because his line managers were confounded by which budget targets they were supposed to hit — the static management assumptions laid out in the annual budget or the rolling B&P numbers.

"The [annual] budget is like drawing a line in the sand," posits Rose Melillo of Murray Inc., the Lawrenceburg, Tennessee-based manufacturer of snowmobiles, lawnmowers, and garden equipment. Four times a month, Melillo uses software from CODA Financials to adjust sales and inventory forecasts, but for the sake of securing loans or lines of credit, for example, "the budget is what [stakeholders] measure you against." Melillo, who shortened Murray's six-month budgeting process to six weeks, adds that "we don't change our goal, we change the way we reach the goal."

Case in point: Last year, Wal-Mart canceled a major order of Murray minibikes in the middle of the budget cycle, leading Murray to discontinue the line entirely. When management decided to stop production of minibikes, notes Melillo, the company didn't change the corporate revenue goal — it immediately redirected the revenue loss into another product line. In this case, Murray beefed up its sales and marketing efforts of lawnmowers to an underserved customer — the U.S. armed forces— and reached its annual target.

The Devil in the Details"Excel is the best modeling tool on the planet," says Thomas Malone of SRC Software, but as a collaborative database and reporting tool, it falls short." Malone, the CEO of the budgeting and planning software provider, notes that battle-tested real-time B&P software "has only been available for the last four or five years, and companies are not aware of its practical capabilities."

Perhaps dread, rather than lack of awareness, is the largest reason that managers have avoided rolling budgets, muses Malone's colleague Philip Sandstrom. Many managers believe that rolling budgets require the same level of detail as annual budgets, says Sandstrom, SRC's finance chief, and they've been scared away by the thought of tackling this beastly project more than once a year.

To help managers conquer this fear, says Sandstrom, top management "has to make it clear that rolling budgets require only summary information" — say, at the district level, not the cost-center level. The goal is to give managers a big-picture view of short-term performance. Line managers should pass along material operational details to the CFO, notes Sandstrom, but many of the minutiae don't need to be shoehorned into a rolling budget.

Culture ClubSuccessful adoption of B&P technology often rides on "the philosophy of the plan," says David Foley, senior director of financial planning at 24 Hour Fitness. "Does the rolling budget just look like support for the finance function, or can operational managers recognize the business value?"

Foley's initial concern was to ensure that his regional budgets, which rolled up the profit-and-loss statements of more than 300 individual health clubs, reflected the way the retail outlets made money. For starters, Foley made sure his modified rolling budgets talked the talk of health clubs.

Instead of requiring managers to populate the system with price points handed down from the finance department, the budgets reflect the staffing hours and membership rates that are the life blood of each outlet. Every quarter, using performance management software from Longview Solutions, Foley rolls up the regional numbers to measure budget variances against corporate assumptions.

According to Foley, the company made a cultural adjustment by using technology to bridge the gap between finance and operations, and to eliminate the uneasiness that operations managers felt about building budgets. More important, managers can recognize the inherent business advantage in the new budgeting process. For example, they can more easily identify if a club is spending too many staff hours teaching low-revenue-producing group exercise classes and not enough time focusing on more-lucrative one-on-one personal training sessions.

Dispelling the fears and misconceptions of line managers is important to the adoption process, but it's only a part of the reshaping of corporate culture, which is essential if rolling budgets are ever to take hold.

Key, of Lake Business Development, suggests starting the cultural revolution by deconstructing compensation plans to give line managers control over their goals. She suggests linking compensation to key performance indicators rather than top-line numbers, because revenue can spin out of control through no fault of the line manager. Witness the manager that receives a bonus based on business unit revenues, says Key. If the CEO decides to use that unit's surplus to buy a new business, the manager has been set up to fail, and worse, forfeit the bonus.

However, getting beyond such legacy compensation schemes is easier said than done, admits Gregg Gracheck, product manager of FRx Software's Forecaster tool. By his lights, drawing KPI into the process can pay off — provided that management figures out what the company should be measuring.

For example, if a company measures the rise and fall of market share as part of B&P, it should also take into account the cause of the fluctuation, then compensate managers based on how well they fix the root cause. For example, says Gracheck, market share often drops when customers are dissatisfied, so customer service managers might have incentives tied to raising the performance of their call centers.

The flip side, according to CODA's Roche, is the frequently seen disconnect between line managers and the budget, in which a company may hit its quarterly revenue numbers but run expenses way over budget to do so. Roche blames that kind of practice on a corporate culture that "links bonuses to revenues and not performance."

Management will also have to eliminate the "I have to spend" mindset before rolling budgets can take hold, asserts Andrew Kamlet, vice president of marketing for FRx. In most organizations, operations managers are forced to spend their entire budget in a given calendar year or risk losing it the next. In a company that's serious about adopting a rolling budget, says Kamlet, time won't run out; pending plans will be revised as quarters or months are rolled out, and managers will be able to plan more judiciously.